Practice Problems

Set Number 3

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 Practice Problems - Set Number 3
Commodity Forwards and Futures
Commodity futures pricing, for storable commodities, is very similar to Financial futures pricing.
However storage costs are usually an additional factor and the dividend equivalent is usually
referred to as a convenience yield (CY). The Commodity Futures Price = Soe(r+-CY)×T where r is
the risk free rate,  is storage costs expressed as a percentage and CY is the convenience yield.
The net of convenience yield and storage cost % is called the Net Convenience Yield (NCY) = CY
- .

Therefore the fair commodity Futures Prices can also be expressed as Soe(r-NCY)×T. In the following
5 questions assume continuous compounding.

Q1) The spot price of a barrel of Oil is 35. The risk free rate is 5%, storage costs are 4% and the
convenience yield is 1%. What is the fair price of a 6 month Oil future?

Q2) If a 6 month oil future is offered in the market at 35.75, is there an arbitrage opportunity based
on the futures price derived in Q1)? If so, show the details of the trade and the payoffs in 6 months
if Oil is up 50% or down 50%.

Q3) Using the details from Q1) what convenience yield would make a futures price of 35.75 a fair
value?

Q4) Assume that the spot price for Gold is 1,200. The risk free rate is 3% and the convenience
yield is 1%. Storage costs of $4.00 are paid every 6 months. What is the fair price of a 1 year Gold
future?

Q5) From Q4) if the price of a 1 year futures contact is 1,250 is there an arbitrage opportunity? If
so, show the details of the trade and the payoffs in 1 year if Gold is up 50% or down 50%.

Hedging and performing Asset Allocation with Futures

For questions 6-21 assume annual compounding. For example if the holding period is 6 months
then the compounding factor is (1+r)0.5. Assume the futures multiplier on equity contracts is 250.
By definition the Market or S&P Index has a beta of 1.00.

Equity Hedging
In equity hedging Beta is the most common single measure of equity market risk. Therefore the
general formula to compute the number of futures contracts needed is:
[ 𝑇𝑎𝑟𝑔𝑒𝑡 𝐵𝑒𝑡𝑎 −𝑃𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 𝐵𝑒𝑡𝑎] 𝑥 𝑃𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 𝑉𝑎𝑙𝑢𝑒
𝐹𝑢𝑡𝑢𝑟𝑒𝑠 𝐵𝑒𝑡𝑎 𝑥 𝑆𝑝𝑜𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐼𝑛𝑑𝑒𝑥 𝑥 𝑀𝑢𝑙𝑡𝑖𝑝𝑙𝑖𝑒𝑟

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Q6) You have a portfolio of S&P 500 stocks worth $10Million. During the next year you are
concerned about market turbulence and would like to eliminate exposure to market volatility.
There are 1 year futures contracts available on the S&P 500 Index. If the risk free rate is 5%, the
spot rate of the Index is 2,000 and dividends are assume to be 0 determine the hedge needed to
eliminate volatility.

Q7) Show that the recommended hedge in Q6) works by computing results at the end of year 1 if
the S&P 500 Index is down 50% or up 50%.

Q8) Assume that instead of constructing the hedge using the Futures Beta x Spot Price in the
denominator of the hedging formula you used Futures Beta x Futures Price. At the end of year 1,
what would you hedging results have been in the down/up scenarios?

Q9) Explain and show the attribute of the performance differentials between Q7) and Q8).

Note on Forwards or Futures Settlement: Forwards and Futures can be settled physically
whereby you take delivery of the security or commodity. Or they can be settled in cash, you receive
the difference between the value of your asset and the futures price. In practice most contracts are
cash settled, as it’s generally more convenient. Actually futures settled every day on an exchange
by computing the value of the futures price based on changes in the spot rate. The difference
between the beginning and end of day futures price creates true ups between the exchange and the
client.

Note on settling/closing out a Futures before expiration: Assume you were long a 1 year futures
on the S&P Index that trades at 1,000, with a risk free rate of 5% and no dividends. The futures
price is 1,000 × (1.05) = 1,050. At the 1 year expiration, settlement = +(Stock Index – 1,050),
assuming a single contract and no multiplier.

However if on the other hand you wanted to close out the contract after 6 months the settlement
would be computed as follows. Assume the Index is trading at 1,200 in 6 months and the risk free
rate hasn’t changed. The price of a 6 month futures contract would be 1,200 × (1.05)0.5 =
1,229.6341.

To close out the Long Contract that has 6 months left you would offset it with a short positon that
expires in 6 months. You execute as follows:
Current position, Long a Futures contract: + (Stock Index – 1,050)
Want to offset with a Short Contract with same maturity: - (Stock Index – 1,229.6341)
Net payoff (as the Stock Index positions cancel out): 1,229.6341 – 1050 = 179.6341

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Q10) Continuing the example introduced in Q6). Assume that you wanted to hedge for 9 months
but could only sell 1 year future contracts in the market but could buy any maturity when you want
to settle the contract. Show you results in 9 months when you close out the contract. Compute the
result with and without “Tailing the Hedge”. Show the results for both approaches, when the Index
is down 20% or up 20%.

Q11) Explain and attribute the performance differential between the “Tailing” and “Non-Tailing”
results in Q10).

Q12) You have a portfolio, of Small Cap stocks worth $25Million, that has a beta of 1.50. 1 year
futures are available on the S&P 500 Index. The risk free rate is 5%, the Index spot rate is 2,000
and dividends are 0. During the next year you expect the market to drop so you decide to positon
the portfolio to have a beta of -2.00. Compute the hedge needed.

Q13) If the market ends down 20% and the Small Cap portfolio is down 32.5% how did the
portfolio, that includes the hedge, perform?

Q14) Compute the effective beta of this hedged portfolio. Is it in line with what you were
expecting?

Fixed Income Hedging

Effective Duration is the most common single measure of Fixed Income market risk used in
hedging. The general formula used for hedging Fixed Income is to compute the number of
futures contracts needed as:
[ 𝑇𝑎𝑟𝑔𝑒𝑡 𝐷𝑢𝑟𝑎𝑡𝑖𝑜𝑛 −𝑃𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 𝐷𝑢𝑎𝑡𝑖𝑜𝑛] 𝑥 𝑃𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 𝑉𝑎𝑙𝑢𝑒
× Yield Beta
𝐹𝑢𝑡𝑢𝑟𝑒𝑠 𝐷𝑢𝑟𝑎𝑡𝑖𝑜𝑛 𝑥 𝑆𝑝𝑜𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐹𝑢𝑡𝑢𝑟𝑒𝑠 𝐼𝑛𝑑𝑒𝑥 𝑥 𝑀𝑢𝑙𝑡𝑖𝑝𝑙𝑖𝑒𝑟

Q15) A portfolio manager (PM) holds $20Million of US Corporate Bonds that have a duration of
10.00. The PM is concerned that interest rates are going to rise in the next year and wants to reduce
the duration to 3.25. She can hedge the position using 1 year Treasury Futures that have a Futures
price in 1 year of 101,000 (multiple of 1.00). That futures price is based on a risk free rate of 2%
and income/coupon of 1%. The treasury future has a duration of 6.00 and a yield beta with
corporate bonds of 1.25. Recommend the hedge for the next year?

Q16) Given the same information as in Q15) except now the portfolio manager (PM) thinks rates
are going to fall as the central banks is expected to become more aggressive about quantitative
easing. If the PM wants to double the portfolio’s duration for the next year what trade would you
recommend?

Q17) If after you position per Q16), rates drop 50bps and the bonds are worth $21.00M. The
treasury Futures Contract value is 103,397. What is the ending portfolio value?

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Q18) Compute what the implied Duration for the hedged portfolio was over the last year based
on the results in Q17). Remember that an estimate of the change in portfolio value is: $Portfolio
Change = - Duration × Change in Rates × $Portfolio Value0. Therefore solve for the implied
Duration over the last year.

Q19) If you want the portfolio described in Q15) to behave like cash over the next year (that is
have no market volatility) recommend a hedging strategy.

Note on the Price Value of a Basis Point (PVBP)

One other metric that is often used in fixed income hedging is the Price Value of a Basis Point
(PVBP) which is equal to Duration × Portfolio Value0 × 0.0001. The value of 0.0001 is equal to 1
Basis Point (bps) = 1/10,000 and the PVBP is an estimate of the change in value that a 1bps
movement would have on the portfolio.

You may notice that there is no sign change attached to the Effective Duration. This is by
convention and it’s what’s used in system like Bloomberg etc. So therefore you need to know that
for instance if the PVBP for a bond is $20,000, that implies that the bond will lose approximately
20,000 per one basis point increase in rates and will gain approximately 20,000 for one basis point
drop in rates.

Q20) The PVBP for a $100M portfolio is $85,000 and the PVBP for a $100,000 treasury futures
(Index Value) is $50. If the portfolio manager wants to hedge the portfolio to have an Effective
Duration of 0, how many futures contracts would they need to trade? The multiple is 1.00 for
treasury futures and the yield beta is 1.25?

Q21) If the PM in Q20) wanted to target a duration of 4.00, recommend a futures trade.

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 Solutions to Problem Set Number 3
A1) Futures Price = Soe(r+-CY)×T
= 35e(0.05+0.04-0.01)×0.50
= 36.4284
A2) The arbitrage opportunity is = 36.4284 – 35.75 or 0.6784.

To capture the arbitrage, buy the underpriced futures contract and hedge that exposure as follows:
Cash Flows at Various Levels
Cash Flow Time 0 17.50 52.50
Buy Futures Contract 0 17.50-35.75 52.50-35.75
Short Oil +35.00 -17.50 -52.50
Receive Storage Costs (see below) +0.7213 +0.7213
Pay Convenience Yield (see below) -0.1789 -0.1789
Lend Proceeds @ e0.05×0.5 -35.00 +35.8860 +35.8860
Total 0 +0.6784 +0.6784

Storage Costs = Future Value with Storage Costs - Future Value without Storage Costs
= 35e(0.05+0.04-0.01)×0.50 - 35e(0.05- 0.01)×0.50 = 36.4284 – 35.7071 = 0.7213
Convenience Yield = Future Value without Storage - Future Value without (Storage and CY)
35e0.05×0.50 - 35e(0.05-0.01)×0.50 = 35.8860 – 35.7071 = 0.1789

A3) Solve for CY where 35e(0.05+0.04-CY)×0.50 = 35.75

e(0.05+0.04-CY)×0.50 = 35.75/35.00
(0.05+0.04-CY) = Ln(35.75/35.00) / 0.50
CY = -[Ln(35.75/35.00) / 0.50 - 0.05 – 0.04) = 4.7596%

A4) Since the storage costs are provided as discrete amounts, the Futures Price
= Soe(r-CY)×T + Future Value of Storage Costs.
The Future Value of Storage Costs = 4.00 e0.03×0.50 + 4.00 = 8.0605
Future Value = 1,200e(0.03-0.01)×1.00 + 8.0605 = 1,232.3021

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A5) The arbitrage opportunity is 1,250 - 1,232.3021= 17.6979. The futures contact is overpriced.
To realize the profit, sell the Futures and hedge the exposure.
Cash Flows at Gold Levels
Cash Flow Time 0 600 1,800
Sell Futures Contract 0 1,250-600 1,250-1,800
Long Gold -1,200.000 600 1,800
Pay Storage Costs -8.0605 -8.0605
Receive Convenience Yield (CY)* 12.3038 12.3038
0.03×1.00
Borrow Proceeds @ e +1,200.000 -1,236.5454 -1,236.5454
Total 0 +17.6979 +17.6979
*Convenience Yield = Future Value without (Storage and CY) - Future Value without Storage
[1,200 e(0.03)×1.00) - 8.0605] - [1,200 e(0.03-0.01)×1.00) - 8.0605] = 12.3038

A6) The general formula used in equity hedging to compute the number of futures contracts is:
[ 𝑇𝑎𝑟𝑔𝑒𝑡 𝐵𝑒𝑡𝑎 −𝑃𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 𝐵𝑒𝑡𝑎] 𝑥 𝑃𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 𝑉𝑎𝑙𝑢𝑒
𝐹𝑢𝑡𝑢𝑟𝑒𝑠 𝐵𝑒𝑡𝑎 𝑥 𝑆𝑝𝑜𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐼𝑛𝑑𝑒𝑥 𝑥 𝑀𝑢𝑙𝑡𝑖𝑝𝑙𝑖𝑒𝑟
[ 0 −1.00] 𝑥10,000,000]
In our case that is equal to = -20 Contracts. Short/sell 20 futures contracts.
1.00 𝑥 2,000 𝑥 250

A7) The portfolio is either down 50% or up 50%. The Futures price of the Treasury Contract is
So × (1+r)1 = 2,000 × (1+0.05)1 = 2,100. Futures Payoff at 1,000 will be -20 × 250 × (1,000 –
2,100) = 5,500,000 and payoff at 3,000 will be -20 × 250 × (3,000 – 2,100) = (4,500,000)

Cash Flows at Various Levels

Cash Flow Time 0 1,000 3,000
Own the Portfolio 10,000,000 5,000,000 15,000,000
Short 20 Futures 0 5,500,000 -4,500,000
Net Cash Flows 10,000,000 10,500,000 10,500,000
Portfolio Return is 10.5M/10.0M -1 = 5%, the risk free rate

A8) Using the futures Price in the Denominator would have resulted in:
[ 0 −1.00] 𝑥10,000,000
= -19.04762 Contracts.
1.00 𝑥 2,100 𝑥 250
The portfolio results would be: Futures Payoff at 1,000 = -19.04762 × 250 × (1,000 – 2,100) =
5,238,095.24 and payoff at 3,000 , -19.04762 × 250 × (3,000 – 2,100) = (4,285,714.29)
Cash Flows at Various Levels
Cash Flow Time 0 1,000 3,000
Own the Portfolio 10,000,000 5,000,000 15,000,000
Short 20 Futures 0 5,238,095.24 -4,285,714.29
Net Cash Flows 10,000,000 10,238,095.24 10,714.285.71

Portfolio Return: 10.23809524/10.0M-1 = 2.3809% in down scenario and 7.1429% in up scenario.

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A9) In Q8) the portfolio is underhedged by 0.95238 (20-19.04762) contracts. In other words the
hedge is only for 19.04762 / 20 or 95.238% of the target. That implies that the results in Q8) will
be a weighted average of 95.238% hedged and the balance of 4.762% exposure to the market.
The returns can be decomposed as follows:
Weighted Return = 0.95238 × Risk Free + 0.04762 × Market Return
Weighted Return Index @ 1,000: 0.95238 × 0.05 + 0.04762 × -0.50 = 2.2809%
Weighted Return Index @ 3,000: 0.95238 × 0.05 + 0.04762 × +0.50 = 7.1429%

A10) In Q6) we solved for a hedge of -20 contracts with a futures price of 2,100. If we are to settle
these short futures in 9 months we need to close out the position through offsetting with a long
futures position. If the Index is down 20% to 1,600 in 9 months then a 3 month futures price is
1,600 x (1.05)0.25 = 1,619.6356. If the Index is up 20% to 2,400 in 9 months then a 3 month futures
price is 2,400 x (1.05)0.25 = 2,429.4534.
Value at close of Down Market = -20 × 250 × (1,619.6356– 2,100) = 2,401,822
Value at close of Up Market = -20 × 250 × (2,429.4534– 2,100) = -1,647,267

Cash Flows at Various Levels: Without Tailing the hedge

Cash Flow Time 0 1,600 2,400
Own the Portfolio 10,000,000 8,000,000 12,000,000
Close our Futures 0 2,401,822 -1,647,267
Net Cash Flows 10,000,000 10,401,822 10,352,733
Portfolio Return 4.01822% 3.52733%
Expected return is (1.05) -1 = 3.727%. Let’s see what results are with “Tailing the Hedge”.
0.75

Since there is a time mismatch between the 9 month term of the investment and the 1 year term
for the future contact, “Tailing the Hedge” will improve the hedge’s precision.
The time mismatch between the term of the contact T = 1.00 and the investment horizon of t =
0.75, is 0.25 years. Therefore our initial hedge solution should be adjusted by a tailing factor of
1 [ 0 −1.00] 𝑥10,000,000 1
. Resulting in × = -19.75753 Contracts.
(1+𝑅𝑖𝑠𝑘 𝐹𝑟𝑒𝑒)0.25 1.00 𝑥 2,000 𝑥 250 (1+.05)0.25
Value at close of Down Market = -19.75753 × 250 × (1,619.6356– 2,100) = 2,372,704
Value at close of Up Market = -19.75753 × 250 × (2,429.4534– 2,100) = -1,627,296
Cash Flows at Various Levels: With “Tailing the Hedge”
Cash Flow Time 0 1,600 2,400
Own the Portfolio 10,000,000 8,000,000 12,000,000
Close our Futures 0 2,372,704 -1,627,296
Net Cash Flows 10,000,000 10,372,704 10,372,704
Portfolio Return 3.727% 3.727%
Expected return is (1.05) -1 = 3.727%. The results are precise with “tailing the hedge”.
0.75

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A11) The returns in the Non-Tailed scenario were over hedged by 0.24247 or (-20+19.75753)
contracts. The hedge is 20 / 19.75753 or 101.22723% of the target to deliver a risk free rate.

The returns for the Non-Tailed hedge can be decomposed as follows. Remember the risk free rate
is 3.727% for 9 months:
Weighted Return = 1.0122723 × Risk Free -0. 0122723 × Market Return
Weighted Return Index @ 1,600: 1.0122723 × 0.03727 -0. 0122723 × -0.20 = 4.0182%
Weighted Return Index @ 2,400: 1.0122723 × 0.03727 -0. 0122723 × +0.20 = 3.5273%

[ 𝑇𝑎𝑟𝑔𝑒𝑡 𝐵𝑒𝑡𝑎 −𝑃𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 𝐵𝑒𝑡𝑎] 𝑥 𝑃𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 𝑉𝑎𝑙𝑢𝑒 [ −2.00 −1.50] 𝑥 25,000,000

A12) The hedge would be =
𝐹𝑢𝑡𝑢𝑟𝑒𝑠 𝐵𝑒𝑡𝑎 𝑥 𝑆𝑝𝑜𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐼𝑛𝑑𝑒𝑥 𝑥 𝑀𝑢𝑙𝑡𝑖𝑝𝑙𝑖𝑒𝑟 1.00 𝑥 2,000 𝑥 250
= -175 contracts.

A13) The price of the futures contact is 2,000 × (1.05) = 2,100.

The small cap stock portfolio is down 32.5% and the index is down 20% to 1,600.
Therefore the results of the Small Cap and Futures are :
Ending value for the Small Cap portfolio is: 25,000,000 × (1-.325) = 16,875,000
Futures results are: -175 × 250× (1,600 – 2,100) = 21,875,000
Total Ending Portfolio = 38,750,000

A14) The Portfolio has an ending value of 38.75 Million. On a starting value of 25M gives a
return of 38.75 / 25 - 1 = 55%.

Solving for the Effective Beta (using the CAPM) we have:

Risk Free Rate + (Market Return – Risk Free) × Beta = Portfolio Return
Filling in the Values: 5.00% + (-20.00% - 5.00%) × Beta = 55.00%
Beta = (55.00% - 5.00%) / (-20.00% - 5.00%) = -2.00
The -2.00 beta is what we were expecting / targeting.

A15) First compute the Spot price for the Treasury Futures:
Spot × (1+Risk Free Rate – Income)T = Futures Price
Spot × (1+0.02 – 0.01)1 = 101,000
Spot = 101,000 / (1+0.02 – 0.01)1 = 100,000

[ 𝑇𝑎𝑟𝑔𝑒𝑡 𝐷𝑢𝑟𝑎𝑡𝑖𝑜𝑛 −𝑃𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 𝐷𝑢𝑎𝑡𝑖𝑜𝑛] 𝑥 𝑃𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 𝑉𝑎𝑙𝑢𝑒

The hedging futures needed = × Yield Beta
𝐹𝑢𝑡𝑢𝑟𝑒𝑠 𝐷𝑢𝑟𝑎𝑡𝑖𝑜𝑛 𝑥 𝑆𝑝𝑜𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐹𝑢𝑡𝑢𝑟𝑒𝑠 𝐼𝑛𝑑𝑒𝑥 𝑥 𝑀𝑢𝑙𝑡𝑖𝑝𝑙𝑖𝑒𝑟
[3.25 −10.00] 𝑥 20,000,000
= × 1.25 = -281.25
6.00 𝑥 100,000 𝑥 1.00

Recommended hedge is to short/sell 281.25 Futures Contracts.

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A16) Doubling the portfolio duration would result in a target duration of 20:
[ 𝑇𝑎𝑟𝑔𝑒𝑡 𝐷𝑢𝑟𝑎𝑡𝑖𝑜𝑛 −𝑃𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 𝐷𝑢𝑎𝑡𝑖𝑜𝑛] 𝑥 𝑃𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 𝑉𝑎𝑙𝑢𝑒
The hedging futures needed = × Yield Beta
𝐹𝑢𝑡𝑢𝑟𝑒𝑠 𝐷𝑢𝑟𝑎𝑡𝑖𝑜𝑛 𝑥 𝑆𝑝𝑜𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐹𝑢𝑡𝑢𝑟𝑒𝑠 𝐼𝑛𝑑𝑒𝑥 𝑥 𝑀𝑢𝑙𝑡𝑖𝑝𝑙𝑖𝑒𝑟
[20.00 −10.00] 𝑥 20,000,000
= × 1.25 = +416.6666
6.00 𝑥 100,000 𝑥 1.00

Recommended hedge is long 416.6666 Futures Contracts.

A17) The results and ending values for the hedged portfolio are:
Corporate Bonds = 21,000,000.00
Futures Position: 416.6666 x (103,397 – 101,000) = 998,750.00
Total Portfolio Value = 21,998,750.00

A18) Given that $Portfolio Change = - Duration × Change in Rates × $Portfolio Value0.
The $Portfolio Change = 21,998,750 - 20,000,000 = 1,998,750 with rates down 50bps
Therefore: 1,998,750 = - Duration × 0.0050 × 20,000,000

Duration = 1,998,750 / (0.0050 × 20,000,000) = 19.9875

Very close to the target of 20.00.

A19) To get the portfolio to behave like that cash, which implies little of no change in market
value, is equivalent to targeting a duration of 0.

[ 𝑇𝑎𝑟𝑔𝑒𝑡 𝐷𝑢𝑟𝑎𝑡𝑖𝑜𝑛 −𝑃𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 𝐷𝑢𝑎𝑡𝑖𝑜𝑛] 𝑥 𝑃𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 𝑉𝑎𝑙𝑢𝑒

Therefore = 𝐹𝑢𝑡𝑢𝑟𝑒𝑠 𝐷𝑢𝑟𝑎𝑡𝑖𝑜𝑛 𝑥 𝑆𝑝𝑜𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐹𝑢𝑡𝑢𝑟𝑒𝑠 𝐼𝑛𝑑𝑒𝑥 𝑥 𝑀𝑢𝑙𝑡𝑖𝑝𝑙𝑖𝑒𝑟 × Yield Beta
[0.00 −10.00] 𝑥 20,000,000
= × 1.25 = -416.6666
6.00 𝑥 100,000 𝑥 1.00
Short or sell 416.6666 future contracts.

A20) The PVBP for the $100M portfolio is 85,000 which implies the following:
Duration × 0.0001 × 100,000,000 = 85,000
Duration = 85,000 / (0.0001 × 100,000,000) = 8.50
The PVBP for the Futures Contract is 50 which implies the following:
Duration × 0.0001 × 100,000 = 50
Duration = 50 / (0.0001 × 100,000) = 5.00
[ 𝑇𝑎𝑟𝑔𝑒𝑡 𝐷𝑢𝑟𝑎𝑡𝑖𝑜𝑛 −𝑃𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 𝐷𝑢𝑎𝑡𝑖𝑜𝑛] 𝑥 𝑃𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 𝑉𝑎𝑙𝑢𝑒
Therefore 𝐹𝑢𝑡𝑢𝑟𝑒𝑠 𝐷𝑢𝑟𝑎𝑡𝑖𝑜𝑛 𝑥 𝑆𝑝𝑜𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐹𝑢𝑡𝑢𝑟𝑒𝑠 𝐼𝑛𝑑𝑒𝑥 𝑥 𝑀𝑢𝑙𝑡𝑖𝑝𝑙𝑖𝑒𝑟 × Yield Beta
[0.00 −8.50] 𝑥 100,000,000
= 5.00 𝑥 100,000 𝑥 1.00
× 1.25 = -2,125.00
Short or sell -2,125.00 future contracts.
If you are targeting a 0 duration then a quick way to get the above result using the PVBP is
PVBP(Portfolio) / - PVBP(Futures ) × Yield Beta = 85,000 / -50 × 1.25 = -2,125.00
For other target duration it’s easier to first solve for the duration, as we first did and compute the
more elaborate formula.
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A21) Since you have solved for the raw durations you can simply complete the following:
[4.00 −8.50] 𝑥 100,000,000
= 5.00 𝑥 100,000 𝑥 1.00
× 1.25 = -1,125.00
Using the PVBP you could solve as follows:
First compute the PVBP of your target: Target Duration x 0.0001 x $Portfolio Value0
= 4.00 x 0.0001 x 100,000,000 = 40,000

Using PVBPs, solve for the Futures contracts trade:

= [PVBP(Target) – PVBP(Portfolio)] / PVBP(Futures) × Yield Beta
= [40,000 – 85,000] / 50 x 1.25 = -1,125.00

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